Corporate private sector dimensions in planted forest investments1

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1 Corporate private sector dimensions in planted forest investments1 D.A. Neilson 2 There has been a major change in forest land ownership over the past 30 years from government and integrated forest product ownership to institutional, equity fund and high net wealth ownership. Most of this activity has been in the United States, but it has recently spread to a number of southern hemisphere countries and also to Europe, Asia and Africa. Over US$50 billion has been invested by North American institutions alone and new fund sources are emerging. Investments in forest lands have shown a high return with a negative correlation to other investments and with low volatility over a prolonged period. Investors consider a number of macroeconomic, political, commercial and biological risk factors when assessing investment opportunities. Several Asian countries exhibit their own set of investment risk challenges compared with other continents. Accordingly, investors ascribe high risk premia to such investment opportunities. Changes in risk premia in several Asian and non- Asian countries between 2000 and 2007 are addressed. Several new forest land investment opportunities are emerging in Asia and other regions, and they are also associated with global climate change/carbon and biofuel issues. 1 This paper is reproduced from FAO (2007): Corporate private sector dimensions in planted forest investments. Planted Forests and Trees Working Paper FP/40E. http: 2 DANA Limited, PO Box 392, Rotorua, New Zealand. Web site: 293

2 Corporate private sector dimensions in planted forest investments Commercial investments in natural forest around the world hold their own increasing challenges as the global market place for wood products seeks sustainable assurances. Keywords: planted forests, private sector, investments, incentives, risk assessment, carbon trading The role of the market in global planted forest development Most planted forests around the world were initially established by governments. This was a natural occurrence as governments owned most original forest land and so were charged with managing these forests after harvesting (which in many instances meant planting trees) or played active national good roles in establishing new planted forests (for example the United Kingdom, South Africa, Australia, New Zealand and Chile). These initial public investments in planted forests by governments were often production driven, to provide future wood supplies for processing expansion and/or to demonstrate methods for planted forests management. From the early twentieth century, private ownership of planted forests became more common; this trend accelerated after 1950 as global forest product processing companies expanded planted forest areas to secure wood resources for existing and future processing demand. This productiondriven mentality by integrated forest product companies continued until the late twentieth century. However, since then, increasingly the private sector has responded to international and national market signals and commercial opportunities to invest in planted forests purely for financial returns. Since the 1970s, some governments decided to sell off all or part of their plantings to private owners. These have included the governments of Chile, New Zealand, South Africa, Portugal and some Australian states. Most of these sales have involved the government continuing to own the land, while selling the trees and rights to grow future rotations on that land. The major reason why land has not been sold is the complications related to future indigenous people s land claims. More recently, some governments have provided long-term land concessions to companies in order to grow trees. These countries include Indonesia, Malaysia, China and the Russian Federation. However, there are still major parts of the world, for instance Central and Eastern Europe, Western Asia and Africa, where government forest ownership is still dominant in the industry, and so a market influence on forest ownership is not significant. This situation may change in the future as increasingly democratic governments realize that owning forests is not paramount to the national interest. 294

3 Dennis Neilson Recent changes in corporate ownership of planted forests It is only recently that substantial ownership of planted forests has moved from a productiondriven motivation (mostly to secure wood supplies for processing) to more commercially motivated reasons. As a result, ownership patterns have changed and continue to change. The major ownership change trends are discussed hereunder. The relaxation of investment and trade restrictions has facilitated increasing globalization, including international investment opportunities in planted forests. Since the 1980s there has been a significant rise in the ownership of planted forests around the world by institutional pension and endowment funds. This development commenced in the United States, with domestic institutions wanting to diversify their investment portfolios. One such diversified category was North American planted and managed native forests. In 2007, this region remained the focus of most planted and managed native forests owned by institutional funds, although there were also other smaller funds based in Europe, Oceania and Latin America. One reason for these phenomena was the frustration of shareholders in listed forest product companies not being able to realize the true value of their planted and managed native forest holdings in the companies share prices. The only way to gain recognition was to liquidate their forest holdings. At the same time that more companies wanted to sell their forests, more and more institutional funds wanted to buy them a perfect match. The scale of the ownership change from forest product companies to institutional and other owners has been phenomenal. For instance, in 1981 forest product companies owned 23.5 million hectares of managed forests in the United States. By the end of 2007, they will probably own less than 6 million hectares. In contrast, the investment by institutional funds in global planted and managed native forests has increased from less than US$1 billion in 1985 to perhaps more than US$30 billion in Most sales of forests by companies have occurred for the above reason in North America, but they have also occurred in Finland, Sweden, South Africa, New Zealand and Australia. New management vehicles had to be established in order to manage the initial investment and then the ongoing management of institutionally-owned forests. To accommodate this need, there has been an increase in the number of Timber Investment Management Organizations (TIMOs) from only two to three in the early 1980s to more than 25 in Of these, six to seven are investing outside North America. The TIMO vehicle suits many institutional investors who may not want to directly buy and manage planted forests, or may want to put only small amounts of their funds into investment and so need to have a structure that can accumulate funds from many organizations to provide large funds. TIMOs are not publicly traded and tend to establish funds which invest for about ten years only. There are some funds, however, which are so attracted to planted forest investment that they may buy and arrange management independent of TIMOs. These include the Harvard University Endowment Fund and the Ontario Teachers Pension Fund. Another vehicle that has developed in North America recently is called the Timberlands Real Estate Investment Trust (T-REIT). These are tax efficient, publicly-listed vehicles and have grown rapidly since The largest private planted forest owner in the world (Plum Creek) is a T-REIT. Since 2004, the investment assets of a number of forest product companies have been restructured into T-REIT vehicles, which are more tax efficient for stakeholders and this process continued in

4 Corporate private sector dimensions in planted forest investments Since about 2005, yet another class of forest owner has emerged the huge hedge funds that may buy and sell, or buy and hold vast tracts of planted and managed native forests. The ocean of inexpensive credit available until mid-2007 enabled these funds to often outbid forest product companies, TIMOs and REITs to acquire large areas of planted forests. Often they would immediately set out to break them up into smaller parcels to resell. The liquidity crisis of late 2007 may reduce this trend; although the pressure of vast amounts of money still in the global system may simply be too great for any temporary credit crunch to have a measurable effect in the medium term. Indeed if these new North American-based planted forest investor types are grouped together, their total investment is estimated to be about US$50 billion in 2007, up from only US$2 billion in 1990 and US$16 billion in Since 2005 there has also been the development of a number of European-based private and listed funds that are investing in planted forests in both Europe and in other parts of the world, including the United States and Australia. Some have been formed specifically to invest where potential carbon trading rights are an attraction. Another new phenomenon in planted forest investment is the development of specialist country funds. For instance, in 2007 a Colombian planted forest investment fund was launched; a similar Japanese planted forest fund may be launched in Yet another new source of funds is emerging that could play a serious role in planted forest investment beyond This is the rapidly growing sector called the Sovereign Wealth Funds (SWF). At the end of 2006, a total of perhaps US$2.5 trillion dollars 4 was held by these funds to invest; with the top 20 of these funds (ranging from the US$875 million Abu Dhabi Investment Authority to the US$10 billion New Zealand Superannuation Fund) holding more than US$2 trillion dollars. 5 Six of these funds are located in Asia. The funds could grow to US$5 trillion by 2010 and to 12 trillion by 2015, providing a vast amount of wealth-seeking investment homes. TIMOs and T-REITs tend to invest only in planted forests. They shy away from native forests, and to date have invested in only a small number of overseas countries/regions where they have concluded that strong government institutions and judicial independence exists. These include Oceania, Chile, Brazil, South Africa and Uruguay. To date, they have not yet invested significant amounts of money in Asia or sub-saharan Africa, although one fund based in the United States is establishing some planted forests in Tanzania. It is also important to note that only rarely do TIMOs or T-REITs invest in planted forest expansion. They may replant after harvesting (and indeed in some regions they do not even do this), but only a small number, and only in very selected regions, seek new land to establish an increasing planted forest area. This may change as the opportunity to invest in existing forests diminishes. The major concerns about investing outside core regions include the perception of a lack of land tenure security, strong governance of administrative institutions and an independent judiciary. 3 Hancock Timber Resources Group, August Morgan Stanley, March Another new SWF, China Investment Corp. Limited, with US$200 billion to invest, was launched in late September

5 Dennis Neilson A series of rogue investment companies that tempted international investors into bad teak projects in both Central America and India in the 1980s and 1990s has slowed a natural expansion into these planted forest options. However, in 2007 several institutions and high net wealth individuals closely examined teak and other native hardwood replacements. Escalating land prices will limit teak expansion, in Latin America at least. Planted forest investors are now being pushed to (at least) consider hardwood investments in relatively risky countries. International investment to date in the Russian Federation and China has largely been via major European and Japanese forest product companies securing resources for processing plants. However, a few listed companies (mainly in Canada) are also expanding their planted and managed native forest holdings in both China and the Russian Federation, with one company delivering superb (sixfold) returns to its shareholders from 2005 to late However, while many western forest product companies have decided to sell their planted forests to institutional funds (and to instead rely on long-term contracts for future wood supplies) a major exception is occurring with Japanese pulp and paper companies. They have been investing (by themselves, or in joint venture) in fast growing mainly hardwood crops in many countries including Australia, Chile, Ecuador, Brazil, South Africa, Lao PDR and China to secure future supplies of pulpwood fibre. At the end of 2006, Japanese companies owned or controlled hectares of overseas planted forests, with a total target area of more than hectares. And these targets are increasing. For instance, following the purchase of a major planted forest resource in Northern Brazil in late 2006, Nippon Paper Company had met its goal of a hectare overseas estate; but in 2007 again raised its target area by another hectares. Another company, Oji Paper Company has a target to raise its existing hectares of pulpwood estate to hectares by A challenge for these companies is that they are increasingly running up against competition from (tax free) pension/endowment funds in the United States in seeking to secure land and planted forests. Mobility of investments TIMOs and T-REITs and other international investors expect a competitive return on their investments within acceptable levels of risk around the globe. If the levels of risk become unacceptable and/or the returns on investment insufficient, then they can sell down their investments and invest elsewhere. While planted forest investments are very immobile (being locked onto the land they are planted in) planted forest investment funds by contrast have become very mobile in recent years. It is now common for TIMOs especially to buy planted forests and managed native forests, and then sell down part or all of them within a decade. TIMO funds are set up to have about a ten-year life span and it is most common for them to be wound up at the end of those periods, or before. Even endowment funds may buy and sell on very short time frames. For instance, The Harvard Endowment Fund recently bought and then resold over hectares of forest land (mostly in the southernmost United States) over an 18- to 24-month period. A hedge fund bought all of the USA-based Boise Cascade planted forests in the United States in 2005 and reparcelled and resold them to TIMOs within 12 to 18 months. In addition, pension investment funds are also 297

6 Corporate private sector dimensions in planted forest investments mobile. For instance, Australian and New Zealand pension funds are investing in planted forests not only in both countries, but also in the United States. This short-termism of the new planted and managed native forest owners may be creating a new set of problems, including fire management and long-term wood supply security (or lack of it) for wood-processing companies. Incentives subsidies There has been one very important factor that has linked almost all successful planted forest expansion projects internationally. This is the application by governments of generous direct subsidies, and/or tax concessions to planted forest establishment and management. There is always much criticism about providing free handouts, or tax concessions to any project. Such schemes invariably attract fast money investors who are only motivated by greed and not by the worthiness of the project itself; it also invariably means that planted forests are established in the wrong areas, outside sensible guidelines for suitable soils, rainfall and other factors necessary to grow a successful tree planted forest crop. The reality, however, is that without generous payment/concession schemes, major planted forest expansion projects rarely, if ever, get off the ground. One of the most successful global planted forest schemes was initiated by the Chilean Decree Law 701, which ran from the early 1970s to the mid-1990s without change. Under this scheme selected companies were able to plan for a long-term planted forest expansion programme, knowing that most of their development and management costs were going to be re-imbursed by the Chilean Government. This scheme has transformed the Chilean forest product industry into a world giant. Another very generous tax-based scheme occurred in Brazil from 1967 to the early 1980s, which significantly expanded the softwood planted forest base. However, as expected, expansion stopped almost immediately after the scheme was cancelled, and Brazil now suffers from a planted forest softwood shortage as a result. A more focused subsidy scheme established by the Uruguayan Government successfully increased the area in planted forests in that country, which in 2007 was probably the world s most attractive country for overseas planted forest investors. A change to the tax structure in New Zealand in 1992 enabled a major expansion of its planted forest resources for the next decade. Very attractive subsidies and tax concessions enabled Indonesian pulp companies to establish several hundred thousand hectares of fast growing eucalyptus and acacia crops. These subsidies have caused the loss of huge areas of native forest, but they have to some extent achieved their objective in developing a planted forest industry. Unfortunately (until recently at least), lax monitoring of these schemes allowed some entrepreneurs to greatly benefit from them without necessarily establishing or properly managing trees, and many have since failed. Generous subsidies and land rental deferment policies in Viet Nam have enabled a very large planted forest base to be established by (mostly) small farmers. A recent subsidy initiative in Kenya for planting pine trees has commenced and looks promising, if suitable monitoring audits can be put in place and maintained. 298

7 Dennis Neilson Presently, one of the most attractive tax concession schemes for expanding planted forests is offered by the Australian Government and has resulted in several hundred thousands of hectares of new planted forests being established since the late 1990s. Because of its structure, most of the money invested has come from small, independent investors, paying into syndicated Managed Investment Scheme (MIS) projects. Demand for this scheme has been so great that it has forced up the price of rural land from A$3 000 per hectare to A$ over the last five years, and has caused serious competitive issues with farmers. This scheme attracted almost US$540 million into planted forest investment funds in 2006/2007. Some schemes that have worked in the past can later falter and may ultimately fail. For example, generous subsidies and tax incentives provided by the Government of the United Kingdom from the 1970s to the 1990s encouraged a major expansion of commercial softwood planted forests. Many of these incentives are still in place, but are now being redirected to basically noncommercial hardwood species, with a major disincentive to replant conifers. Not surprisingly, in spite of incentives, new planted forest expansion has plummeted. This is an example of a planted forest incentive policy basically failing, because it is targeting a planted forest philosophy that does not attract investors. And not unsurprisingly, if this deconiferization policy that the United Kingdom has apparently adopted is not reversed, wood shortages in that region may become chronic. The positive impact of generous subsidies and/or tax concessions can been seen in a great many examples around the world; and in contrast, investor behaviour in not planting trees which occurs without subsidies or when subsidies are removed, provides a very clear picture of the critical importance of incentives to global planted forest development. Risk assessment for investors in planted forests International planted forest investors are regularly faced with a dilemma when choosing investment options. It is common for the safest, least risky investment options, for example in a standard species/ regime in the United States, to attract only modest returns, when by contrast the potential returns in countries, regions, species and management regimes deemed to be more risky may be much higher. Such investment decisions are always a trade-off. The 2007 Tree Farm and Managed Forest Industry Review actually provided matrices of IRR returns versus Country Attractiveness Ratings for almost 100 case studies of softwood sawlog, hardwood sawlog and pulpwood investment options around the world. There is now a growing number of well-established independent consulting firms that provide independent advice on investment proposals almost anywhere in the world. They range from multinational consulting firms, to large- and medium-sized country-specific or region-specific service firms. Many have now had decades of experience advising on valuations and due diligence of the full range of planted forest estates in both temperate and tropical countries. Different investors will have different risk profiles and the country base of investors will affect their appetite and perception of risk. For instance, a Chilean investor may assess less risk in investing in Argentina than an investor in the United States would. Or, an Indian investor might 299

8 Corporate private sector dimensions in planted forest investments assess less risk in investing in planted forests in Cambodia or Lao PDR than a German investor. By examining international transactions of planted forests around the world it is possible to determine the risk profiles of various investors. It should be emphasized that it is very difficult to properly assess values of planted forests. Because of the long-term nature of even a single crop investment and the large amount of international trade of wood products from most large planted forest countries, decisions on such basic factors as what discount rate to use, future currency exchange rate movements and future log price assumptions can seriously impact a valuation. Assessment of potential future nonwood values further complicates the process. In 2007, the Boston-based RISI organization 6 completed a major review of global tree farm investment attractiveness. 7 Using a proprietary template of 13 risk parameters it determined an attractiveness score for 70 countries from 1.0 (extremely risky) to 7.0 (no risk). In its survey it determined the least risky country was the United States. Other attractive countries/regions included Scandinavia, Western Europe, Oceania and Chile. Medium-risk countries included Argentina, China, Bulgaria and Viet Nam, while risky countries included Uganda, Cambodia, Madagascar, Angola and Zimbabwe. Tables 1 to 5 show examples of scoring and ranking for the most attractive of the 70 countries reviewed by RISI; along with the eighteenth country, the thirty-sixth country, the fifty-second country and the worst country (#70). The tables illustrate how overall attractiveness scoring was developed and provides some assistance in understanding what investors look for in selecting investments in various countries. It is clear that high scores for policy consistency and in an independent judiciary are requirements for a high planted forest investment attractiveness rating and ranking against competitor countries The global tree farm and managed forest industry review 2007 edition. 8 These risks reflect the international private sector/corporate investor risk profiles. Local smallholder investors may spread their risks with other activities (e.g. agroforestry), have lower expected returns and may attribute non-financial values to their planted forest assets. 300

9 Dennis Neilson Table 1. Timberland investment attractiveness # 1 United States Parameter Score Parameter Score Policy consistency 7 Land tenure 7 Inflation 6 Land availability 7 Economic climate 7 Market accessibility 7 Deviation from PPP 3 Biological and physical risks 6 Strength of judicial system 6 Corruption 6 Total score in Foreign ownership provisions 7 Transport infrastructure ranking 1 Local labour costs ranking ranking 6 Table 2. Timberland investment attractiveness # 18 France Parameter Score Parameter Score Policy consistency 6 Land tenure 7 Inflation 7 Land availability 2 Economic climate 4 Market accessibility 7 Deviation from PPP 2 Biological and physical risks 5 Strength of judicial system 5 Corruption 5 Total score in Foreign ownership provisions 5 Transport infrastructure ranking 18 Local labour costs ranking ranking 8 Table 3. Timberland investment attractiveness # 34= China Parameter Score Parameter Score Policy consistency 5 Land tenure 4 Inflation 7 Land availability 3 Economic climate 2 Market accessibility 7 Deviation from PPP 6 Biological and physical risks 4 Strength of judicial system 2 Corruption 3 Total score in Foreign ownership provisions 3 Transport infrastructure ranking 34= Local labour costs ranking 28= 1997 ranking

10 Corporate private sector dimensions in planted forest investments Table 4. Timberland investment attractiveness # 52 Macedonia Parameter Score Parameter Score Policy consistency 3 Land tenure 4 Inflation 5 Land availability 3 Economic climate 3 Market accessibility 3 Deviation from PPP 6 Biological and physical risks 5 Strength of judicial system 2 Corruption 3 Total score in Foreign ownership provisions 3 Transport infrastructure ranking 52 Local labour costs ranking na 1997 ranking na Table 5. Timberland investment attractiveness # 70 Zimbabwe Parameter Score Parameter Score Policy consistency 1 Land tenure 1 Inflation 1 Land availability 3 Economic climate 1 Market accessibility 4 Deviation from PPP 6 Biological and physical risks 3 Strength of judicial system 1 Corruption 1 Total score in Foreign ownership provisions 2 Transport infrastructure ranking 70 Local labour costs ranking ranking 57 The increasing demand for planted forest assets being chased by more and more buyers has reduced the returns on timberland investment. For instance, RISI estimates that average returns on forest lands in the United States fell from 9 percent in 2001 to 6 percent in 2004 and to 4.5 percent in Other industry observers suggest that real returns from many recent investments will be only 3 to 4 percent. 9 Risk assessment from a government and society viewpoint Recent experience has shown that some governments and NGOs have taken a very hard, negative line on large-scale commercial planted forest expansions, especially in developing countries. The ogres of monocultures, indigenous people s displacement, the loss of diversity of both planted forest and animal species and of non-wood economic activity in forests by villagers, the potential loss of water 10 and soil erosion and carbon issues have all been raised as negatives. As 9 Because neither United States-based TIMOs, nor their largely institutional funding base pay tax in the United States, pre- and posttax returns are effectively the same. When TIMOs invest overseas, they may be subject to the tax laws of the countries they invest in, but most have developed funding mechanisms that are able to eliminate all or most of their tax liability. 10 Water issues have stopped the development of planted forests in South Africa, which uses less than 10 percent of the nation s water, while sugar-cane farming, which uses almost 50 percent of the nation s water, has been allowed to continue almost without restrictions. 302

11 Dennis Neilson a result, sound planted forest expansion programmes have floundered in many countries. In contrast however, massive expansion in agribusiness crops such as palm oil, the expansion of numbers of highly polluting farm animals and rapid urbanization (all of which are far more harmful to the environment and to indigenous people than almost all tree crops) has been tolerated with almost no criticism. There are now several internationally credible services to study impacts of planted forest expansions in any location, and dozens of international case studies that can identify the positive and any possible negative results of major planted forest expansion programmes. There is no need to re-invent the wheel in this regard. In spite of environmental and social NGO criticism, for all major planted forest expansion programmes that have been responsibly managed, governments and citizens mostly look back on them decades later with a positive view. The need for clear, consistent, concise strategies to support planted forests There are numerous examples around the world that illustrate the positive effect that clear government strategies and standards can have on the expansion of planted forests; and conversely several examples where their absence can hinder or prevent expansion. There are even several examples of where governments have changed policies, and as a result planted forest expansion has all but ceased. Case studies of planted forest development and the role that governments played to ensure that investment was encouraged include the United Kingdom (to the 1990s), the United States, Australia, New Zealand (to the 2000s), Chile, Brazil, Uruguay, South Africa (to 2000), Viet Nam, Spain and Portugal. Equally there are case studies of how a lack of government support and/or a lack of land tenure security and/or the lack of an independent judiciary have hindered development. Examples would include the United Kingdom post-1990s (when it abandoned a supportive role for commercial species), South Africa post-2000 (since then interdepartmental fighting between Forestry and Water has all but ceased expansion in a wood-starved area), Angola, Mozambique, Zimbabwe, West Africa, Cambodia, Lao PDR, Guatemala, Mexico and Paraguay. Ironically, it is often overzealous and top-down interventions by governments and NGOs which have resulted in disappointing or failed planted forest results, especially with Community Forest Enterprises (CFEs). A July 2007 report by the International Tropical Timber Organization (ITTO) 11 identifies major challenges in avoiding the sidelining of these enterprises. It provides examples of the huge gap between official plans and actual control by villagers. Examples include the following: 11 The ITTO report discussed both native and planted forests. 303

12 Corporate private sector dimensions in planted forest investments In Gambia, hectares have been categorized as community forests, but only hectares are actually in the hands of local villagers. In Cameroon, 4 million hectares are designated for communities, yet only hectares (1 percent) are approved for legal use. Unfortunately, well-meaning NGOs claim that people, particularly in richer countries, are needed to start paying for global CFEs. Well, they are not likely to start in any meaningful way if there is not something in it for them. This requires political and social stability and governments setting standards and then letting the market act as it should. There have been huge government and NGO investments in planted forest development in countries like Ivory Coast and Cameroon that have not succeeded. In contrast, for instance, once heavy government intervention and well-meaning NGO support of planted forest projects in Viet Nam largely ceased, then sustained and commercially successful planted forest projects (mainly controlled by small landowners) could begin to thrive. And they have. Lessons from these failures, and the many success stories discussed in this paper should be reviewed; lessons should be learned and then applied. It is not difficult for governments to create supportive policies. They just have to be clear and concise and be left basically untouched for at least a decade to engender confidence that money invested will not be wasted or misappropriated. Even the recent decision of the New Zealand Government (for decades considered to be a planted forest-friendly developed country) to nationalize carbon credits from private forest ownership 12 has resulted in a revolt by private planted forest owners and an almost complete cessation of planted forest expansion. Economic valuation of wood and other non-wood-based products For decades the single value driver for tree planted forest developments has been wood production. There are sometimes variations on wood-only valuations, but they themselves rely on wood value changes. For instance, some investors have benefited by purchasing a planted forest that is valued by the owners as one wood quality type (e.g. pulpwood), but for which the investor can identify more valuable wood types (e.g. sawlogs or ply-logs). Or, an investor may be able to change the planted forest management regime to produce more high value products than the vendor may have been able to identify. But in all of these variations, the only product being valued was wood. Traditionally, an investor might have ascribed a lower discount rate if a long-term wood supply contract was in place with a major wood product company. This is because that contract could be identified to be all or part securitization, hence reducing the risk inherent in selling logs on a spot market in future. However, recently the major planted forest asset buyers (TIMOs and 12 The New Zealand Government, possibly bowing to forest owner pressure, announced a new carbon policy in September 2007 that will allow owners an option to be allocated carbon credits beyond However, the full implications of the new policy have yet to be analysed. 304

13 Dennis Neilson REITs) may actually ascribe a negative value to a planted forest that has long-term wood supply contract obligations. Most of these owners prefer to have their wood supplies unencumbered, so they can take account of market forces. Also, traditionally the valuation of planted forests grown on freehold (or fee simple) land assumed that the cost of land would be entered as a positive cost at the start of the investment cycle, and then counted as a negative cost, with the same real value, at the end of the investment cycle. This standard valuation process assumed that the land would not increase in value over time, and so should be included in any valuation as a holding cost only. Non-market values, such as social and environmental services that the planted forests may provide to society (nutrient sinks, protection of soils and water and other amenity or recreational values) have not played a major role in valuation or trade in these major wood product companies. However, if society values them sufficiently to pay for their services, then this could change in the future. Higher and better land use (HBU) In the last decade, and especially in the last five years, however, planted forest investors who can also own the underlying land have found that much of the inherent value of the planted forest is actually in the land itself. The term Higher or Better Land Use (HBU) has been coined in the United States, as millions of hectares of planted/managed native forest land have been reassessed during and after purchase as what it is worth in an alternative land use. Large tracts of forest land may be subdivided and sold as smaller units. This wholesale to retail process generally allows investors to attract higher bids for smaller blocks, even if the land use (planted forestry) remains the same. In addition, selected areas (and sometimes all) of the planted forest may be subdivided and sold off as hunting and recreational blocks, or for residential or industrial subdivisions. The term HBU reflects a higher market value of the land and a better return on investment but does not necessarily reflect more responsible land use. This process started in a small way in the United States in the 1980s when the St. Joe Pulp Company decided it could add value to its planted forests by shutting its pulp mill, and then by breaking up its vast planted forest area in Florida into non-wood uses: residential subdivisions, airports, towns and so forth. This has been a very successful strategy, and now more and more owners are seizing upon this opportunity to add value not to the trees, but to the land. A recent sale of hectares by Weyerhaeuser in the state of Georgia in the United States was broken up approximately equally into timberland 13 and HBU land before it was sold and marketed to different groups of people. The identification that the land value may actually be the controlling influence has spread to other countries. In Latvia, for instance, international investors have added greatly to the value of managed forest investments by selecting forests that may be rezoned in future as they are located close to towns or they may have rock/gravel quarries on them that have not been recognized. In New Zealand one investor recently purchased fee simple planted forests and immediately 13 Timberland is the American term for forest land. 305

14 Corporate private sector dimensions in planted forest investments commenced removing the trees and converting the land to dairy farms. One (covering more than hectares) will probably be one of the largest contiguous dairy farms in the world. By changing land use the investor increased the value of its investment severalfold. Of course this non-wood value is only available if the investor owns the land and also if government regulations allow a land-use change. Increasingly, authorities are placing limits on land use, sometimes related to carbon issues (see below). Carbon trading and the impact on planted forest values There has probably been more hype about the use of trees in carbon emission abatement schemes in the last decade than any other topic in the forestry world. And the debate and the confusions continue. The potential and (in rare occurrences) the actual opportunity to utilize carbon credits produced by growing trees had it roots in the 1992 United Nations Framework Convention on Climate Change. Originally forests were going to be left out of any future protocols by major policymakers, but a small group of planted forest experts managed to persuade the Convention that forests should be bundled up in an agreement, so they might be considered to provide carbon sequestration in future. By 2007, however, one of the main architects of including native and planted forests in the 1992 protocol has apparently lived to regret this decision. 14 In a meeting in New Zealand in August 2007 at a conference to explore post-kyoto climate change options, he said that for various reasons forestry should be omitted altogether. He (and no doubt others) has found that it is not just the international tortuous policy maze or the mind-boggling complexity of measurement that is a problem; it is that so few people actually understand the dynamics of forests (including planted forests) related to the carbon cycle. An investigation of just how many carbon-based planted forest projects that have been accredited makes for lean pickings. Notwithstanding the myriad of problems, however, the possibility of gaining positive carbon credits and future carbon trading values is attracting increasing numbers of investment consultants and investors globally. The Australians have been pioneers in carbon trading contracts based on planted forests. However, they have generally been contracts between two government departments in the same state (e.g. a government-owned forest manager and a government-owned power station manager); or they may have been for an option to the carbon at a later date, if future trading was ever allowed. Some Japanese pulp and power companies have paid deposits for this right over Australian planted forests. New South Wales was the first government in the world to write legislation that enables planted forest owners to legally separate the land, the trees and the carbon, so all their assets can be owned by different entities. In late 2006, the New Zealand Government sanctioned what it has described as the first carbon project in the world to be sanctioned by a government and which is Kyoto-compliant. This 14 New Zealand Journal of Forestry, August

15 Dennis Neilson project was developed under what is known as the Permanent Forest Initiative, which allows the carbon ownership and trading of a forest established and not harvested for at least 35 years (and then thereafter always leaving a permanent canopy). European institutional money will reportedly fund the project. In 2007, a number of companies were listed on the AIM stock exchange in London to attract international funds for planted forest investments involving the added benefit of future carbon trading. However, up to 2007 at least, the impact that possible carbon trading rights have had on attracting new investment money to expand planted forest areas has been modest. In contrast, recently there has been much media attention about the carbon sequestration value of preserving existing native forests through reduced deforestation and degradation, known as REDD. For instance, two studies of tropical and of temperate forests suggest that it may be more valuable to preserve native forests for their carbon values than harvesting. 15 At the 2006 rate of US$20 for a one-tonne unit of carbon dioxide, the forests of Bolivia, Central African Republic, Chile, Congo, Costa Rica, Democratic Republic of Congo, the Dominican Republic, Guatemala, Nicaragua and Papua New Guinea (coalition members) are reportedly worth about US$1.1 trillion for their carbon sequestration alone. These forests offer a great deal more value through the other, less measurable services they provide including fisheries protection, biodiversity preservation, erosion and flood control, recreation and tourism value, harvest of renewable products and water services. A recent study by the Pembina Institute for the Canadian Boreal Initiative found that carbon stored in Canada s boreal forests and peatlands is worth US$3.7 trillion, while the annual value of ecosystem services like water filtration, pest control services and carbon storage is US$93 billion, roughly 2.5 times greater than the net market value of forestry, hydroelectricity, mining and oil and gas extraction in Canada s boreal region. The values can be expected to be similar in tropical countries. 16 These studies are all very well as hypothetical ideas, but do not have much value until some government, or organization actually decides that it will outlay this sort of money to preserve these forests. The impacts of bioenergy production and planted forest development The bioenergy revolution, which started in Austria and Sweden in the early part of this decade, is now rapidly spreading around the world, although it is still largely focused on Europe and North America. The major raw material for wood-based power generation has been wood pellets. In late 2006, a total of 288 wood pellet plants were operating in Europe, up from only 236 plants in In 2006, 80 pellet plants were operating in the United States, with another 28 expected in Biofuel is now being traded across continents, with, for instance, biofuel shipments being made from Latin America and North America to Europe, and it is believed, Japan. 15 mongabay.com. 16 mongabay.com. 17 Bioenergy International. 307

16 Corporate private sector dimensions in planted forest investments In 2006 to 2007, several governments decided to promote the use of ethanol as a substitute for gasoline. Brazil has been the pioneer in this effort, although most of the raw material has been sugar cane. The EU has a mandate for having 5.75 percent of all transport fuels as biofuels by The United States has embarked on a huge bioethanol expansion programme, but is mostly based to date on food products such as maize. The United States administration has announced a goal for a sevenfold increase in the use of biofuels, to 35 billion gallons, by The International Energy Agency forecasts that global use of ethanol will increase from 51 billion litres in 2006 to 120 billion litres in The same organization predicts that biodiesel demand will grow from about 3.5 billion litres in 2005 to 24 billion litres in There are still significant technical hurdles to be overcome before wood can be used in a costeffective way to manufacture either ethanol or biodiesel. Major research into developing viable projects based on lignocellulosc ethanol production was conducted in 2007 in the United States, Japan, Sweden and New Zealand. Other work is being carried out on converting lignocellulose to other fuels such as butanol. To date, however, there does not appear to be any specialist wood-based planted forest expansions specifically designed to meet this increasing demand. Waste wood from forests and woodprocessing plants is being used including sawdust and woodchips. Recently major areas of wind-, insect- or fire-damaged forests in Europe, Sweden and the United States are being targeted to supply wood raw material for bioenergy use. The use of fast growing popular species is being investigated in Central Europe and New Zealand to grow biofuel crops. It is believed at least some of the roundwood harvested from a eucalyptus planted forest in the Republic of Congo will be sold from 2008 to European power stations as biofuel. A woodchip plant and fibre export facility was built for this operation in One species has been recently identified as an exciting plant to grow for future biofuel production. This is Jatropha curcas, which is a drought-resistant, inedible oilseed-bearing tree that does not require the good quality soil that would normally be used for food crops. The Government of India has singled out jatropha for large-scale planted forests and various government agencies offer subsidies and easy soft loans to individuals and companies investing in jatropha planting. 18 The biodiesel content of its seeds is reported as 35 percent. Jatropha can live up to 50 years and can provide seeds up to three times per year. 19 In mid-2007, British Petroleum and D1 Oils announced that they were to form a 50/50 joint venture, to be called D1-BP Fuel Crops Limited, to accelerate the planting of jatropha. Under the terms of the agreement, BP and D1 Oils intend to invest about US$160 million over the next five years. D1 Oils will contribute its hectares of existing planted forests in India, Southern Africa and Southeast Asia, and the joint venture will have exclusive access to the elite jatropha seedlings produced through D1 Oils plant science programme. It is anticipated that some 1 million hectares will be planted over the next four years, with an estimated Prospects for Jatropha biofuels in developing countries: An analysis for Tanzania with strategic niche management by van Eijck and Romijn; Eindhoven Centre for Innovation Studies,

17 Dennis Neilson hectares per year thereafter. 20 If this planned project is implemented, it would become the largest single project tree planting programme anywhere on the globe. Overall outlook in planted forest investment As discussed above, massive investments have been made in planted and managed native forests by institutional and high net wealth investors over the last decade. However, almost all this investment has gone into existing planted and managed native forests and has not been spent on expanding the area of planted forests (with a few, very minor exceptions in Latin America). The actual expansion of planted forests has historically been directly correlated with clear governmental support for this process, coupled with affordable land purchase/rent costs and identified markets for wood products. The alignment of many of these positive factors in several countries, which occurred from 1960 to 2000, is no longer so obvious. The great expansions in both government and private sector forest areas in South Africa, Australia (softwoods), New Zealand, Chile, the United States and elsewhere have effectively stalled. The Chinese Government is clear in its intention to expand planted forests. It is notable, however, that the area of timber planted forests in China actually diminished by 4.1 percent to 23.2 million hectares from 1998 to During the same period the area of other (probably protection) planted forests increased by 82 percent to 9.1 million hectares. 21 RISI (2007) predicts that China s operable timber planted forests will increase from about 25.5 million hectares in 2005 to about 29.5 million hectares in The supergenerous tax breaks for planted forests in Australia are continuing to allow expansion there, at least until land prices limit affordability (many would suggest that this is already occurring). Future demand for pulpwood fibre is driving expansions of planted forests in Brazil, Malaysia and Viet Nam; and is even starting in Lao PDR. Continuing expansion of planted forests in Indonesia was expected, but in late 2007 a major standoff between the Department of Forestry and the police has stalled conversion of native forests to planted forests. The police are reported to be re-assessing the legality of all existing permits to convert native forest land to planted forests. 22 Historically much of this land conversion process was controversial and has been widely criticized by environmental groups and NGOs. Various companies and investors are investigating major expansions of planted forests in sub- Saharan Africa, where there may be in excess of 25.5 million hectares of land suitable for planting south of the Congo River. 23 This land is on sites that have more than mm (40 inches) of annual rainfall, are in humid or semihumid climates and are on slopes greater than 8 o (given that food production would be paramount on flat land). This was almost 15 percent of the total global area in planted forests in 2001, as assessed by FAO (and probably more than 20 percent 21 China s National Forest Inventory. 22 Industry sources. 23 Sappi (2002). 309

18 Corporate private sector dimensions in planted forest investments of the actual global areas surviving). However, major political policy, corruption and other issues have to date severely limited the conversion of this potential into viable projects. For decades, planted forest investment (whether undertaken by governments or private enterprise) was driven by patient funds. Investors used to accept a period of 20, 30 or even 50 years or more between planting and harvesting. This is no longer the case. Most investors now want to be able to harvest trees within five to 15 years. So future planted forest expansion trends will be for shorter crops and for processing technological innovation to allow added value solid wood processing of young trees. Continuing investment in existing planted forests by institutional funds can be expected, which will be re-arranging ownership of existing assets, but will not likely add to the global planted forest resource. Loss of planted forests to HBU will likely continue. In addition, increasing competition from major agribusiness crops including palm oil and maize (often heavily subsidized by governments) and by new rapidly expanding biofuel crops such as jatropha will likely continue to drive up global land prices and rents. This trend will limit planted forest expansion rates it is already happening in Indonesia, Malaysia and Brazil; planted forest expansion in Thailand had faltered recently as farmers were being paid more for growing tapioca than for growing even short rotation eucalyptus tree crops. The continuing loss of native forests in Africa, Asia and Latin America (in spite of the best efforts to slow the rate of forest destruction), will likely lead to growth in wood prices from planted forests. It is becoming apparent that available native forest resources in Indonesia and Malaysia have diminished rapidly since The large-scale harvesting of native forests in Africa to feed Western, and more recently, Chinese industries will have the same effect within five to ten years. Changes to tax policies in major wood-producing countries, e.g. the Russian Federation, may also lift wood prices. Entrepreneurial efforts to raise funds for multi-use planted forests, including wood, carbon and biofuel values are likely to increase establishment rates somewhat, even if locating suitable land becomes more difficult. The rapidly growing Indian economy will require more wood resources in the future. To date, very restrictive government policies have limited the expansion of planted forests in India, but this may change. In the meantime, some Indian companies are deciding that they will expand planted forest areas in other countries, such as Malaysia and Lao PDR. And finally, regional political blocs may become a new catalyst for planted forest expansion. They would do this in conjunction with goals and targets related to reducing greenhouse gas emissions. For instance, the leaders of the Asia Pacific Economic Cooperation (APEC) in their agreed target of reducing energy intensity by 25 percent by 2030, pledged to increase forest cover in the Asia Pacific region by at least 20 million hectares. 310

19 Dennis Neilson Conclusions Over the past 50 years, most countries that have measurably expanded their sustainable, commercial planted forest base have had some characteristics in common. Most are considered to have stable governments, strong security of land tenure and an independent judiciary to protect investor rights. Almost all have introduced very generous tax relief of direct subsidy schemes that have operated over long periods of time. These may have been discontinued, or modified once a target area had been established. The most effective way major international institutions such as FAO and the World Bank can ensure similar expansion of private planted forest investments in developing countries would be to encourage and assist governments to adopt measures to improve security of land tenure and to ensure that investors are protected by independent legal systems. The ownership of planted forests in many countries in North America, Oceania and Latin America has been transformed in the last 30 years and accelerated in the last five to ten years, from mainly government and integrated forest product ownership to institutional funds and private equity funds ownership. This process continues with additional funding sectors entering into this sector. There are many initiatives from governments and political blocs to substantially increase the area of planted forests in future, largely driven by the global warming and carbon sequestration issue. However, the mechanisms to identify and secure the land necessary for this expansion; and specific funding sources are still not known. Planted forest expansion will encounter an increasing amount of competition, in both developed and developing countries from food production projects, many of which are now also becoming a source of raw material for biofuels. 311

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